When planning for your retirement, it’s essential that you understand how your pension will work. In the UK, the two most common types of pension are Defined Benefit and Defined Contribution pensions. Each operate in different ways, which will impact your retirement differently. In this article, we’ll discuss some of these differences between these pension types. This includes how the amount you’ll receive is determined and what happens to your pension upon your passing.

Which employers offer each pension type

Defined Benefit pensions are usually workplace pension schemes. They are more common for public sector employers, for example the NHS, civil servants and teachers. Some private sector employers may offer a Defined Benefit pension. However, many that have in the past are no longer accepting new members. Instead they’ll offer Defined Contribution pensions for all new enrolments.

Defined Contribution pensions can be private or workplace pension schemes. Nowadays, they are the most common type of workplace pension offered by employers.

How your pension amount is determined

With a Defined Contribution pension, the amount you’ll receive is based on how much is invested and how those investments perform. With workplace pensions, the amount invested includes contributions from your employer and yourself, along with your tax relief. There is a pension annual allowance determining the maximum you may invest in your pension each financial year in order to receive tax relief. For the 2025-2026 financial year, this is £60,000 or 100% of your annual salary, whichever is lower.

The amount you’ll receive with a Defined Benefit pension is based on your final salary before retirement, or your career average salary during your time in the pension scheme, depending on how the scheme is set up. It is a guaranteed income for the rest of your life, as determined by the rules of the pension scheme. The amount you will receive is calculated using an accrual rate. This is detailed by the pension scheme, and is expressed as a fraction or percentage.

Example

If you have been a member of a Defined Benefit scheme for 20 years, whose pay-out is based on your final salary, in this case £30,000 with an accrual rate of 1/60:

Your annual pension will be £500 for each year you have been a member of the pension scheme (your final salary (£30,000) multiplied by the accrual rate of 1/60).

As you have been a member of the scheme for 20 years, your annual pension from this scheme will be £10,000 (£500 x 20 years).

Who makes investment decisions

With a Defined Benefit pension, significantly less involvement is required from you compared to with a Defined Contribution. Your employer will instruct a Board of Trustees, whose responsibility it is to ensure your pension funds are invested well. Whilst there is no onward impact if the pension funds do not perform well, as your pension amount is guaranteed, it is in the interests of your employer for them to perform. Should there be a shortfall in the amount in the pension pot compared to the guaranteed pension amount, the employer covers this cost.

With Defined Contribution pensions, you are responsible for how your pension pots are invested. You must make decisions on how and where your pension pots are invested. If poor decisions are made, your investment may underperform, leaving you with less money for your retirement. We understand how complicated and overwhelming pensions can seem. That’s why we work on behalf of our clients to manage their pension portfolios, ensuring the invested funds perform effectively. Contact us by emailing hi@willdaywm.co.uk or by calling 0116 222 0119 to discuss how we can help you to a financially stable retirement.

Pension protection

Funds invested in your pension, no matter whether a Defined Benefit or Defined Contribution scheme, have protections in place.

A Defined Benefit pension is usually covered by the Pension Protection fund. This means that if your employer goes into administration before you retire, your pension is not in peril. You are still guaranteed to receive at least 90% of your guaranteed income. Defined Benefit pension members who are at or past retirement age will continue to receive 100% of the guaranteed amount.

The protection of Defined Contribution pensions may differ by scheme. Money invested in workplace pensions are usually protected if your employer goes into administration. Both you and your employer will no longer contribute to your pension, but the already invested pot will be safe. If the pension scheme provider closes, you may be eligible for compensation from the Financial Services Compensation Scheme. This could be up to 100% of your pension pot.

Transferring your pensions

If you have moved to a new employer since the workplace pension auto-enrolment was introduced in 2012, you may have multiple pension pots. You may look to transfer your pension into a single pot, taking advantage of the benefits this entails. You can find out more about consolidating your pensions in our recent blog post. For example, you may be able to take advantage of pension schemes with more favourable fees, saving more money in your pension pot for your retirement. This can be more suitable for those with Defined Contribution pensions.

It is not usually worth transferring away from a Defined Benefit pension scheme at the bottom. Cash equivalent transfer values (CETVs) are closely linked to interest rates and while they were very low after the 2008 financial crisis this meant transfer values were very attractive. However, as interest rates have increased again since COVID-19, this is a much less attractive option these days. Additionally, the guaranteed retirement income from this type of pension, has a lower risk attached. Defined Contribution pensions carry a higher risk as they rely on the performance of the investments. There is no guarantee that the value of your investments will rise; indeed they may fall. Transferring funds from a low-risk Defined Benefit pension to a higher-risk Defined Contribution pension is not often advisable unless the CETV is high enough.

Early withdrawal of pension funds

For those with Defined Contribution pensions, depending on pension scheme terms, you can withdraw money from your pension from age 55. This is rising to 57 from April 2028. You can withdraw up to 25% of your pension pot, tax-free, capped for most people at £268,275.

Each Defined Benefit pension scheme will have a pre-determined ‘normal retirement age’, generally age 60 or 65. If you choose to withdraw funds before this time, it will impact your annual pension income once you reach the ‘normal retirement age’. Your guaranteed income level will be reduced, to cover the fact that payments will be made over a longer time period.

What happens to your pension in the event of your passing

For a Defined Benefit pension, the details for this will be defined by the pension scheme, but usually 50% of your annual guaranteed income will continue to be paid to your spouse until their death. For a Defined Contribution pension, this will pass to your chosen beneficiaries specified on your ‘expression of wishes’. It is important to ensure you have completed your expression of wishes form for all of your pension schemes. This will make sure your wishes are followed upon your death.

No matter your pension type, if the pension holder passes away before the age of 75, a tax-free lump sum may be paid. If they pass away after 75, however, pension payments are often taxed as income or the dependent.

From April 2027, the deceased person’s pension will be included in their estate value, and therefore may be subject to Inheritance Tax of 40%.

Understanding how Defined Benefit and Defined Contribution pensions work is essential when considering your retirement. Our experienced and knowledgeable team are on-hand to ensure you understand your projected retirement income. We’ll also help you evaluate your options to ensure your invested money is working in the most efficient way for you.

Get in touch today, by emailing hi@willdaywm.co.uk or by calling 0116 222 0119.